The Use of Marketable Permits for Pesticide Control

Quick Links

Pesticide regulation concentrates almost exclusively on implementing direct controls to reduce the environmental and public health risks associated with pesticide use. The continued use of traditional direct controls to achieve these standards is not the most efficient solution in all cases. Economists have demonstrated the efficiency gains that are available when flexible market based incentive policies are implemented. This study will provide the conditions under which market based policies are efficient, describe the institutional design of these policies, and determine how they can be realistically implemented along side exiting direct control regulation. The determination of what is 'efficient' will be a comparison between changes in economic welfare and changes in environmental quality.

Approach:
To achieve these objectives, we will first develop a theoretical model which describes the interaction of pesticide use and pesticide regulation. This model will incorporate the differences of pesticide use by region, crop and farmer characteristics. The identification of this heterogeneity is necessary for marketable permits to not just be a theoretical possibility, but also a realistic policy alternative. A computable equilibrium simulation model will then be constructed using the information on parameter relationships obtained from the theoretical model. Economic simulations will focus primarily on Methyl Bromide but also look at particular Organophosphate pesticides. Simulations will be used to examine market incentive regulations to limit specific pesticides for markets with uniform and differentiated permits of various dimensionalities all integrated along side existing direct controls.

Expected Results:
Information on and a better understanding of market based policies will allow for more efficient and effective protection of environmental and public health. The results of this research benefit all of society through lower environmental compliance costs, smaller effects of producer competitiveness, improved environmental and health risk management, and the potential to encourage improvements in pesticide use technology that results in more effective and efficient pesticide use.

Objective:
The objectives of this research project are to: (1) implement and analyze a model of permit trading in a segmented market with a small number of input producers; (2) survey the structure of the methyl bromide market in the United States to provide an empirical base for understanding the effects of the introduction of permit trading; (3) develop a conceptual framework and simulate the effects of the introduction of permit trading under both the current regulatory framework and alternative registration requirements (including who receives permits).

Progress Summary:
We developed a framework to compare gains moving from direct control of pollution to tradable permits in pollution rights under conditions of economic and environmental heterogeneity. The impact of pesticides on the environment and health depend on where they are applied. Therefore, it is important to understand the impact of policies with two dimensions of heterogeneity.

Much of the literature comparing standard and financial incentives considered only quotas that prescribe certain levels of action. The literature has ignored restrictions that set upper bounds on polluting activities. Such restrictions frequently are used to regulate pesticides.

We found that when we have uncertainty about both the economic and environmental impacts of environmental policies, the Wietzman (Review of Economic Studies, 1974) framework can be expanded and there is a broad range of circumstances where imposing upper bounds on pesticides or other polluting activities is superior to market-based policies (taxes, subsidies, and trading) and quotas. This analysis enabled us to recognize when there will be gains from the introduction of tradable permits and to identify what types of information are needed to overcome some of the disadvantages of financial incentives because of uncertainty.

We identified two aspects of current pesticide regulations that must be taken into account for the implementation of a tradable permit scheme. First, pesticide registration and labeling represent a distinct regulatory framework that is already in place and constrains the ability to freely trade permits. Second, there are relatively few companies that produce pesticides. There currently is a small number of manufacturers of methyl bromide worldwide. Because of this, methyl bromide producers have significant market power, as demonstrated by the significant price increases for methyl bromide products paid by consumers as production quotas have been decreased. These companies may be able to manipulate any permit trading scheme to maximize their own profits rather than minimize losses to pesticide users. Below, we discuss these issues in more detail.

The U.S. Environmental Protection Agency uses pesticide registration and labeling requirements as mechanisms to control the risks of pesticide use. Pesticide labels are legal documents that attempt to provide direct control of pesticide applications; labels may be thought of as "due care" regulations. Under the Federal Insecticide, Fungicide, and Rodenticide Act, the formulation, packaging, repackaging, and labeling of pesticides must occur at registered establishments. Currently, registration is required at a manufacturing plant level, so that particular manufacturing capacity is allowed to produce and label pesticides for a particular application only. It is illegal to substitute a pesticide intended for a specific application into another application, even if this is technologically feasible. Therefore, there is market segmentation according to the different applications of a pesticide. For example, there presently are around 60 separate labels for methyl bromide products. If each application of a pesticide only has a few manufacturers, these manufacturers will have significant market power.

Tradable permit schemes that restrict trading only within applications are much less efficient than when there are several integrated permit markets. Because pesticide labels are tied to specific manufacturing plants, there may be physical limitations to the ability of transferring tradable permits across different pesticide applications. Our analysis suggests that when establishing permits, it is necessary to consider the breadth of desired trading and the extent to which transferability should be allowed between different pesticide uses. For example, separate markets could be established for methyl bromide applications of a certain type or intensity, or for certain crops or regions. Although the potential gains from trading are largest with a single pesticide market, we also would expect that transaction costs would increase with the number of traders and the variety of underlying uses. Additionally, transaction costs will increase as the number of registration and labeling requirements increases.

Most of the literature on potential trading of pesticide use permits assumes competitive markets, but the small number of pesticide producers led us to analyze introduction of trading in noncompetitive markets. There have been some studies of noncompetitive pollution rights markets where one trader is large enough to influence permit prices and manipulate the market. To our knowledge, however, there have been no studies that consider permits trading schemes with dozens of separate markets but only a few companies. Under competitive markets for pesticides, switching to a tradable permit scheme will always improve the welfare of all pesticide users. If markets are not competitive, however, the introduction of tradable pesticide permits may decrease the consumer surplus of pesticide users in some market segments. This happens because companies with market power choose to "dump" permits into some segments of the market to raise consumer prices in other segments.

When thinking of permit trading schemes, it is natural to assume that pesticide users, such as farmers, will get permits. In reality, however, the established regulatory framework implicitly favors producers as the market participants for methyl bromide. Why is this the case? The Montreal Protocol mandates reduction in noncritical uses of methyl bromide. To date, these reductions have been enforced via production quotas for pesticide manufacturers. These quotas are based on a historical baseline and decrease over time. Given this starting point, a natural way of implementing the tradable permit scheme is to continue allocating production quotas to methyl bromide manufacturers, but allowing them to trade amongst themselves. Such a scheme may generate large rents to methyl bromide producers. We intend to study the impacts of distributing permits to users rather than producers.

From the above discussion, it is clear that it is important to have a good understanding of the establishment and maintenance of pesticide labeling and registration requirements to analyze potential distributional and efficiency outcomes of pesticide permit trading. We assembled information about methyl bromide that will allow us to simulate some of our models and help us in our effort to develop a framework to harmonize tradable permits with other aspects of pesticide regulation.

Future Activities:
Future activities are to:

1. Develop methods to determine optimal breadth of markets in pesticide use permits to allow trading across product categories and labels. This objective is part of a larger objective of reconciling tradable permits with the existing system of labels and registration.

2. Compare outcomes when permits are distributed among chemical manufacturers versus outcomes when they are distributed among users. Conduct conceptual and empirical analyses for methyl bromide.